What Is Cryptocurrency Custody and How Does It Work?

Let’s start with a definition. To fully comprehend the term, you should first have a thorough understanding of financial asset custody. Custodians are the entities that provide a variety of financial services in conventional financial markets. The primary job of custodial service providers within conventional capital markets is asset safekeeping.

Custodians may function as vaults, storing clients’ assets in both digital and physical forms and charging a fee for this service. Furthermore, custodians use their market knowledge to facilitate and expedite the settlement of client trades. But what does crypto custody mean? In the context of cryptocurrency, it is almost the same, as there are commonalities with conventional financial industry custodians. Still, there are a few specifics to cryptocurrency custody that you need to be aware of.

What Is a Cryptocurrency Custodian?

Institutional cryptocurrency custodial solutions are similar to those of conventional capital markets custodians, but with one significant difference; custody solutions for cryptocurrency are primarily concerned with taking responsibility for and protecting clients’ digital currencies, not physical assets. Secure key management is fundamental to the successful storage and processing of crypto data when it comes to storage solutions.

How Does Crypto Custody Work? Public Keys and Private Keys

If we delve deeply into any cryptocurrency wallet, we will discover how the keys are used. In reality, any solution that provides you with custody of cryptocurrency, such as a crypto wallet, does not actually keep your coins.

The private keys are held for you by the cryptocurrency custody provider of your choice. Custody solutions may also assist you in properly managing your cryptocurrency by providing private key access. Private keys are random binary numbers that aid in transaction encryption and decryption. The private keys are used to validate a transaction.

Public keys are essentially long numeric strings that are linked to a certain wallet or custodial solution. They act as the user’s wallet address and should be linked with the appropriate private key when the user executes transactions, such as buy/sell, transfer, convert, or swap.

Cryptocurrency Custody Options: What Is a Crypto Custodial Wallet?

With a thorough understanding of the fundamentals of cryptocurrency custody, it is now time to focus on various categories of solutions. What sorts of custody solutions are available for cryptocurrency? Below are the three most frequent forms of crypto custody services available to both individuals and institutions. A crypto custodial wallet is a sort of cryptocurrency wallet in which the private keys of the wallet are stored by a third-party service provider called a custodian.

1. Self-Custody Wallets

Self-custody cryptocurrency solutions mean you keep the private keys to the crypto assets yourself, using hardware, software, or paper. Self-custody wallets are some of the most popular alternatives for individual cryptocurrency custodial solutions. You safeguard your crypto assets using the hardware, software, or paper wallets that suit your needs. 

The benefits of self-custody systems include increased security and control over your assets. However, you must take full responsibility for your asset, as well as the risks of theft and loss.

2. Exchange Wallets

Another popular approach for cryptocurrency custody involves using wallets on an exchange, such as Exolix. An exchange wallet is a means by which investors and traders make it easier for themselves to exchange, administer and store private and public keys. Users have simple access to their public and private keys through an electronic wallet.

These systems are appropriate for institutional cryptocurrency custody, in which the exchange is responsible for using private keys. Although exchange wallets provide significant simplicity and convenience of access for maintaining cryptocurrency custody, they also pose some risks to counterparties.

3. Third-Party Custodial Wallets

Third-party custodians are another solution for cryptocurrency custody providers. Third-party custodians are service companies that store crypto assets for their clients. Third-party custodians provide the option of implementing custom-defined functions and controls for governing asset management.

Third-party custody solutions provide superior institutional-grade security as well as insurance for enterprise crypto custody. Standardized schemes with strictly delineated rules and procedures for handling crypto assets do provide a potential benefit. Furthermore, third-party custodians provide greater flexibility and security but at a higher cost.

Is Cryptocurrency Custody Safe?

Cryptocurrency custody is not 100% safe, as there always is a risk of hacking or data leakage, but it may be considered “sufficiently safe” because all necessary precautions are taken.

Whenever you use cryptocurrency custody, you are entrusting your money to a system designed and managed by someone else. Because these individuals can make errors or be outwitted by an attacker, any system can only be as safe and secure as the people who create and maintain it.

Having mentioned this, numerous crypto custody systems are created and managed by industry specialists who are fully familiar with the technical and physical issues associated with protecting assets. To eliminate any uncertainty, several custodians offer insurance plans for your assets if particular concerns exist.

Types of Cryptocurrency Wallets

• A wallet constantly linked to the Web is referred to as “hot storage.” Exchanges, for instance, always offer hot wallets that let users withdraw cash promptly.

• Warm storage refers to a wallet that is located on a network interface but still functions without it.

• A cold storage wallet is a device that is not linked to the internet. Transfers are usually undertaken in an “air-gapped” manner, in which transaction authorization occurs on a distinct, offline server rather than on the internet-connected host.

Additional Security Precautions

Two-factor Authentication (2FA) is a method of ensuring that accounts are secured by more than just a password and require a random number or a device to enable access.

Businesses frequently employ address whitelisting to guarantee that cash is only sent to previously approved addresses. This necessitates a hacker having access both to the wallet and the system that keeps this list.

A multi-signature (multi-sig) wallet requires permission via several keys to have access to money and transmit transactions.

To guard against physical assaults, these keys and/or users should be distributed geographically.

The private keys required to begin transactions are better kept cold. The phrase “cold storage” applies to offline storage that prevents transactions from being performed remotely via the internet.

Whenever someone attempts to move funds into a crypto vault, there is a built-in, predefined delay. This is sometimes referred to as a “timelock.” It prevents the cryptocurrency from being transferred for a set period.

Individuals may employ these security features without the assistance of a custody provider, but like with many things in the world, having a professional handle them can be beneficial.

Furthermore, many cryptocurrency custody providers are audited regularly and will pay consultants to try to breach their networks to find and address such weaknesses preemptively.

The Expense of Cryptocurrency Custody

Cryptocurrency custody companies charge for the safeguarding of cryptocurrency in the same manner that banks do for specific checking accounts.

Self-custody users do not pay a fee, but they do spend money on wallets and storage that ensure the private keys are secure.